New IMF Report Advises on Stimulus Exit Strategies

Priority to maintain global recovery, but urgent also to formulate exit strategies

Governments need to start reversing sharp rise in public debt

Timing of policy shift depends on country circumstances, but some actions can be taken now

The global economy is recovering, partly due to the fiscal and monetary support. The cost of combating the crisis around the world runs into trillions of dollars, but recovery would have been slower without the policy support, IMF economists say.

As the crisis winds down, it is now more urgent that policymakers formulate, communicate, and begin to implement strategies for exiting from crisis-related intervention policies, the IMF says in a paper released on February 23 called “Exiting from Crisis Intervention Policies.”

On the question of when to exit, one senior official at a press briefing on the paper said that in principle, “the answer is when private demand is ready to take up the relay and growth can be sustained.”

The timing of policy shifts depends on country circumstances, particularly the pace of recovery and the government debt position. IMF officials had the following key messages:

• Most advanced economies should maintain stimulus in 2010, and begin tightening in 2011 if the recovery proceeds as currently projected.

• Fast-growing emerging markets can start tightening now.

• In some cases, market concerns imply that tightening is needed ahead of recovery.

Big public debt

The officials noted that the crisis has left scars in the form of large public debt increases, particularly in advanced countries. They emphasized, however, that the debt increase reflects mostly revenue losses from the recession, not the cost of the stimulus.

The strategic goal should be to reverse the rise in debt, not just to stabilize it at post-crisis levels. This will take several years and will involve difficult choices and measures, but history tells us it can be done, they said.

Removal of stimulus measures could be done in a phased way, with fiscal measures being unwound ahead of monetary policy. “The reality is that one more year of deficits is much more costly than one more year of low interest rates. So when the choice is available, fiscal exit should come first, monetary tightening second”, the IMF official said.

What can be done now

IMF officials added that actions that do not impact negatively on demand should be implemented now (this can alleviate the tension between exiting too soon and too late). They include reforms in

• Goods, labor, and financial markets, to boost potential growth: a lesson from history is that strong potential growth is key for fiscal adjustment.

Emerging interest rate differences

The officials cautioned that because of the higher growth in emerging markets, interest rates in those countries would probably be higher, but advanced economies should not be tempted to follow suit and should in general still keep interest rates low.

On the financial sector, officials said that support measures should be unwound gradually and will require flexibility and judgment.

The process can be facilitated by incentives that make measures less attractive as conditions improve and by the judicious use of termination dates. A new financial regulatory framework and more capital will be needed to reduce the risks ensuing from the unwinding of crisis-related financial policies. “The culmination of the exit strategy is to put in place a new regulatory system,” they said.

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